Buying a car constitutes a huge capital outlay for most of us. While we all want the best car we can afford, packaging the transaction to make the most financial sense will save thousands over a period of time.
There is no hard and fast rule when it comes to how much deposit is required when a car is financed. Like in the property business, some financial institutions require that at least 10% of the price of a car is paid for in cash upon the initial purchase, the rest of which it will finance. Depending on the size of the loan, others may provide the full 100%.
By far the best way to pay for a car is to pay for it fully in cash. That way you not only immediately save many thousands in interest costs over whatever period a loan is secured for (anything from 6 to 72 months), but are not locked into a financial agreement you may not get out of for the duration of that period. When shopping for a loan, ask very specific questions about the terms and conditions relating to loan period, lump sum payments and early termination.
Interest and loan period
While the purchase price of a car is one thing, the interest you pay on the loan to have it in the first place may amount to an additional 40% of the price of the car if the instalment period is over an extended period of time.
For instance, the cash price of the car you want is R100 000. If you finance it over a period of 72 months (6 years, the maximum allowed in SA at this time) at a rate of 12.5%, your instalment is roughly R1970 a month for a total of around R140 000. The R40 000 is pure interest, equal to 40% of the value of the car when you first acquired it.
Should you pay off the R100 000 over a period of 3 years only, the monthly instalment rises to just over R3300, and the total price of the car is now R120 000. Note that you have saved half the interest costs. Now, have you paid cash from the get go, there would have been no instalment to begin with and no loss in any interest costs.
The danger of residuals
In order to make a new car as affordable as possible, South African financial law allows for a residual value to be placed on a car. It can be as high as 40% of the original value of the car and is only applicable when finance is taken on a car. It is usually only provided through dealer or manufacturer finance.
For instance, a 40% residual on a R100 000 car is R40 000. This means the buyer does not need to immediately pay for and finance this R40K, only the balance of R60 000. It must be obvious that the car is suddenly much more affordable to any new buyer.
At the end of the agreed finance period that the buyers has paid monthly instalments for (3-5 years), the R60 000 + interest portion has been settled, but now the owner still owes the dealer the balance of R40 000 plus interest, payable immediately. Few buyers have this amount in cash, and have to refinance or take out a personal loan to settle the figure.
The danger is also that often the car is worth less than what is owed on it, putting the owner in a precarious position – selling will yield less than what is owed on it, effectively turning it into a liability.
The benefit of residuals are that it makes buying a car more affordable in the short term, allowing you settle the bulk of the payment when you could afford to do so. It is also great if the car is worth more than the residual, putting the owner in a more favourable position, but this scenario is the exception rather than the norm
Even so, the lesson is: do not buy on residual. Stick to what you can comfortably afford. Buy with as much cash as possible Rather buy older and cheaper.
Try one of the online calculators to determine how much payment you could comfortably afford, taking into account deposits (if any), various interest rates and various periods of time: